Northern Juggernaut? A Look Inside the Canadian Economy

Northern Juggernaut? A Look Inside the Canadian Economy

When Canada is mentioned in the international business press, it's often referred to in a positive light. For example, we read about Canada's sound banking system and relatively low public debt, or we hear about its GDP and employment growth that has outstripped other G7 countries. But give us a fuller picture. What is going well in Canada's economy and what is going not-so-well?

It's true that if you look at the so-called underlying fundamentals, we really seem to have distinguished ourselves from the major developed economies. But on the other hand, our record of output during the recession was not much better than that of the United States.

Historically our recessions have tended to be worse than those in the United States. This time we've been hit somewhat more lightly, and that was due to our sounder policies and stronger private sector business fundamentals. So, one could argue counterfactually that the recession might have been worse in Canada without those sound fundamentals.

The other aspect that distinguishes Canada that sounds great at first but is more ambiguous in the long run, is that we've established a better employment record than the other developed economies, particularly the United States. The inverse of that, however, is that our productivity growth rate is fairly low. I think that is truly die Achilles heel of the Canadian economy. If we look at the Canadian economy over the last decade, we've had very little productivity growth--less than 1 percent a year. Despite everything that ailed the US economy, it had productivity growth of over 2 percent a year.

If we look back at the 24 OECD countries starting in the 1960s, Canada used to have the third-highest level of productivity. Now it's 17th. In fact, since 1980, only three of those 24 countries have had a slower productivity growth rate than Canada. So we may appear to be doing quite well in terms of output and employment growth rates, but in terms of productivity levels we're still suffering. That translates into weak household income growth.

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According to Statistics Canada, between 1997 and 2011, Canadian labor productivity declined 17 percent relative to the US. What are some of the reasons for this and what can Canadian policymakers do to close this gap?

Superficially, I would say the number one culprit is that we have underinvested in machinery and equipment in Canada. The best way to increase labor productivity is to give workers a better stock of machinery and equipment to work with. On average, the Canadian worker has just a little more than half the stock of machinery and equipment to work with as his American counterpart.

But, as I said, that's the superficial answer because that just begs another question: why do Canadians have so much less machinery and equipment to work with?

Historically Canadian companies have said that this is because the taxation of capital is very high in Canada. I have some sympathy with that as an historical argument, but that is not the case anymore. All Canadian governments started to bring down their rate of capital taxation beginning in 2000, and we now have much lower rates than the United States. So, in theory, we should have seen an increase in business investment.

We had a potential golden era of investment from 2003 to 2007 because we import much of our machinery and equipment, and the Canadian dollar was rising against the US dollar and almost all other currencies. This meant that imports in machinery and equipment were getting cheaper. Adding to that, corporations had a lot of retained earnings. And yet they didn't increase their business investment very much.

One reason for this could be the historical reliance of Canadian businesses on an undervalued Canadian dollar. This is certainly anecdotal, but a lot of businesspeople have given me the story that they thought the dollar would fall back down in value, so they didn't need to make transformational changes. …

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